“Don’t put all your eggs in one basket.” This nugget of financial wisdom has been around forever and we’ve all heard it at some point. While we’ve all listened to this mantra and generally accept its validity, do we actually put it into practice? Most people think they’re diversifying by purchasing a handful of unrelated stocks and throwing a few bonds into their portfolio for good measure. Many choose to buy shares of a mutual fund and leave the diversification up to the pros. Although this does diversify your investments to an extent, are you really protecting your money from that “perfect storm” that could wreak havoc on your financial well-being?

If you truly want to diversify your holdings and protect your money to the best of your ability, you’re going to have to explore a few alternative forms of investment. This does not mean that I’m advocating taking your retirement money down to the track and betting it on a horse with 100:1 odds. However, if you think your portfolio is diversified by putting your money into various domestic markets, you might be kidding yourself.

When the stock market declines in value rapidly, it may not matter how unrelated your stock holdings are. They might all lose significant value at once. One option that I think you should consider is investing a portion of your money into the foreign exchange market. It provides you with the opportunity to add an uncorrelated element to your portfolio that is not directly tied to the fortunes of any single stock market or economy.

What is the Foreign Exchange Market?

The foreign exchange market, or “Forex,” as its known, is actually the biggest financial market in the world. Over $4 trillion changes hands in this market every weekday. Of course, most of that is traded between large investment banks, but it involves regular investors as well.

In Forex, you’re not buying stocks or commodities or baseball cards. You’re actually buying lots of money. That’s right. You’re trading cold, hard cash. What could be a better investment than money, right? In reality, it’s not that simple, but you get the idea.

When you place a trade in the Forex market, you’re actuallly working with a pair of currencies. Forex brokers combine them together to form currency pairs. For example, a commonly offered currency pair in the market is the Euro/United States Dollar pair or the EUR/USD. Every time you place a trade, you are actually simultaneously buying one currency and selling another. In the example of the EUR/USD pair, if you place a buy order, you’re buying the Euro and selling the Dollar.

So why would you buy one currency and sell the other? You’re hoping the first currency in the pair moves in the direction of your trade. If you buy the EUR/USD, you’re actually hoping that the Euro rises in value as compared to the Dollar. If it does, you’re a winner. If it doesn’t…well, you get the idea.

Low Barriers to Entry

One of the benefits of getting involved in Forex is that it has relatively low barriers to entry. This isn’t like that hedge fund that you couldn’t get into because you didn’t have a net worth of $1 million. Many Forex brokers will let you open an account for $100 or less. Although you probably won’t make much money with a $100 deposit, you could get started trading. Most real traders start with somewhere between $2,000 and $10,000. If you’re looking for another investment to add to your portfolio, you probably only want to invest a percentage of your available funds anyway. This gives you an easy place to start.

Leverage

Another potentially nice thing about Forex is that traders get to use leverage. Since exchange rates between currencies only move ever so slightly over time, it takes a large investment to realize any significant profits. A standard lot of currency is $100,000 when you place a trade. This means that you’ll either need $100,000 for every lot you trade or you’ll need to trade with leverage. In the US, traders can trade with leverage up to 50:1. Traders outside the US can find brokers that offer leverage up to 500:1. This means that you only have to put up a very small amount of your own money to take a trade.

If you’re familiar with trading on margin in the stock market, this is not the same thing. With a margin account, you’re actually borrowing money to trade and if you lose, you have to come up with that money to pay back your broker. In Forex, brokers simply close out the trade when your account balance gets to the minimum margin requirement. If you only put up $2,000, you’re not going to have to come up with $98,000 if you lose your trade. You just lose your investment amount.

Skip the Commissions

If you’ve ever traded in the stock market, you’ve probably thought to yourself, “Why am I paying this outrageous commission to the broker for doing nothing?” If so, you’re probably going to appreciate Forex. When trading with a foreign exchange broker, you typically don’t have to pay commissions. Brokers are paid by collecting the “spread” or the difference between the bid and the ask price on a trade. Although the broker still gets paid, it’s not quite as painful as forking over a commission every time you trade.

Should You Try It?

I’m not going to lie and say that everyone’s going to love trading currencies. It’s not for everyone and it does carry with it some risk. Leverage is a double-edged sword that makes every swing in the market that much more painful when you pick the wrong direction on a trade. With that being said, it can be highly profitable if you figure out how to trade and it also gives you a way to diversify your portfolio. If the stock market crashes, you could actually profit from it by purchasing other currencies as your own currency declines in value.

Before you try it, you’ll need to learn a profitable trading strategy and understand how the market works. If you’re already a stock trader, you should have no trouble picking up the technical aspects of the process. Once you’ve done your homework, you should also open a demo account with the broker of your choice. This makes it possible for you to trade with “Monopoly money” until you feel comfortable.

After you’re more than comfortable with your new trading strategy, open an account and start trading. If you like it, you’ve found yourself a new avenue for earning returns. If you don’t, at least can tell your significant other you didn’t blow your money at the track.

(Luke Arthur is a writer and financial blogger with a Bachelor’s degree in business from Missouri State University . He has written for many financial publications and published a book “Modern Day Parables” which is available on Amazon.com. He is the owner of Forex Trading Rookie which helps beginners navigate the foreign exchange market.)

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEEDor EMAIL updates. You can also find me on TWITTER
and FACEBOOK
. Happy investing 🙂

This post was written by yours truly, Jon Elder. My mission is to help you succeed in your personal finance life. Join me on the journey to financial freedom! You can subscribe through RSS FEEDor EMAIL updates. You can also find me on TWITTER
and FACEBOOK
. Happy investing 🙂